Iycee Charles de Gaulle Summary Paper the firmlevel (micro). It looks forward

Paper the firmlevel (micro). It looks forward

Paper 1 – What determines residual income?This paper looks to determine the real factors affecting the residual income of a firm by usingimpact of value-creation and value-recording and whether abnormal ROE and residual incomecan be used to determine a firms value by studying both industry level (macro) and at the firmlevel (micro). It looks forward to highlight does the firm size, market share and equity affect theresidual income and provide insights on how economic rents affect the abnormal ROE and howdo capitalization of expenditures affect the performance measures and return-earnings ratio. Themethods used by the author to carry out the research are as follows.a. Intrinsic value of a firm under the residual income model (RIM).b. Dividends are not affected by the accounting policies followed; surplus of a firmis only affected by surplus and economic rent.c. Abnormal ROE is directly proportional to the firm size, market share and entrybarriers.d. Mean and median are taken for industry averages.The author found out that the Industry and firms abnormal ROE increases with factors listedabove, the market-to-book ratios increased by 40% in industry and 33% in firm, these factorshelp explain the firm value exponentially higher than the models suggested earlier to thisresearch. Thus we can conclude that, firms abnormal ROE increases with market share, size andconservative accounting factors. Also this research helps in improving the RIM framework andimproves the understanding of the cross-sectional variation in the firm value.Paper 2- Implementing residual income valuation with linear dynamics.This report helps analyze the future accounting numbers (used to calculate residual income) bythe use of linear information models. The research was carried out to find out the link betweendividends, book value and earnings to implement residual income valuation and explain the crosssectional variance of price and book value using linear models. To elucidate his methods theauthors have used the following research methodologies;a. The clean surplus relation – relation between the book value (Bv), accountingearnings(x) and net dividends (d) through time (t). {bvt=bvt-1+xt-dt}b. Finding price function using general class of information dynamics.c. Relying on historical data for the sample space used for the assessment.d. Inconsistency is reduced by taking mean of the data.Research indicated that the median of ROE is 10.7% and median residual income is $-0.72million. Spearman’s rank correlation is significant but points in the wrong direction asconservative firms have higher residual income. The findings in this paper are inconsistent withother models that take conservatism into perspective. Hence we can conclude that linearinformation dynamics do not capture the aspects of market valuation properly. The growth rateof the firm affects the linear study as the growth might not be linear hence linear study ofresidual income is a step in the wrong direction but is essential to value firms.Paper 3 – Cost of Capital in RI for Performance evaluationThis paper looks forward to highlight the flaws in taking the market risk and not firm specificrisk at the time of a manager’s investment decision. The research was carried out to examine theimpact of market risk and firm specific risk on the RI and incorporate WACC (WeightedAverage Cost of Capital) in the investment decisions when using RI theory. To strengthen hishypothesis the author has used the following research methodologies;a. The outcome (income) generated is a function of effort applied by the managerand the capital employed by the principal.b. Managers decision, production choice, contract choice and contract acceptanceare a function of time and hence attract cost of capital as capital is blocked till thetime the decision is made.c. The market risk and the firm risk are not affected by the borrowing and lendingcapacity.d. WACC is incorporated in the RI theory by the use of linear equations as afunction of time. Also no sample space is taken; this paper is a theory paperincorporating WACC in RI approach.With consistent results the author concluded that the assumption of using WACC of market to beadjusted against RI is fundamentally flawed when it comes to manager’s investment decisions incapital assets. Pre decision information does not affect the estimation of RI and has little to noeffect on the WACC and hence the RI. Thus, one may conclude that accountants shouldcarefully assess the impact of managers risk aversion and the differential rates of market v firmto estimate the RI.Paper 4 – Residual Income Risk and Share PricesBasinski and Walen argue that the empirical accounting research provides little to no evidence ofaccounting earning numbers to assess the risk associated with a firm. This paper looks to answerthe risk-relevance of accounting numbers. Existing research methodology put higher emphasison risk related to pay off than to risk related to the firm. The paper looks to answer two basicquestions-? Are accounting risks related to the cross sectional differences in share price.? Are accounting risks associated with market assessment and pricing of equity.To strengthen their arguments the authors have used;? Mean of 1990-1998 has been taken for book value, dividend payout andforecasted ROE for 800-1000 firms.? Risk factors like the market share, price and size of the firm have beenincorporated in the RI approach by subtracting the dividends and then reducingrisks as per the factors that affect the specific firm by multiplying it with beta(residual income risk).? Spearman’s rank correlation is used to distinguish the residual income riskmeasures that are related but not substitutes.? Regression is used to estimate the abnormal ROE on equally weighted averageROE over the period of 10 years.The study depicted that it is not clear how one can incorporate risk into the empirical study of RI,also this paper developed a new way of measuring risk on share price by using observed shareprice over risk-free value (measured using risk-free rate of return and RI). Market price and RIhave a positive beta when put through multiple regressions. Thus we can conclude that residualincome and share prices have a positive relationship when it is assessed with factors like marketshare, firm size and the systematic risk involved in the business. Hence, RI plays a major role indetermining the current market price of a firm.Paper 5 – RI based valuation to predict future stock returns.The paper looks to analyze the value-price ratio to predict future annual returns of a share for upto 3 years based on RI valuation framework. Ali hwang and tromli look to examine value-priceratio and its concentration of future earnings. Also it aims at enhancing the understanding ofmispricing effect of prices on the future stock returns. For this the authors have used thefollowing methods;? Frankel and Lee’s primary measure of firm’s value has been taken as the base tofind out the value of a firm rather than the traditional methods of finding RI andvalue of a firm.? Markets to price ratios have been taken for the end of June of 1977-1992.? The abnormal returns indicated in the firms future returns is being tested by theuse of market beta and quintiles.? The value to price ratio has been taken out using the market prices as it reducesthe incorrect measurement or omission of risk factors in the evaluation of shareprices.? Additional methods used for evaluating the market price consist of usinghistorical data for forecasting and by regressing valuation measures on the futurereturns.After research, the authors were able to conclude that;? The value to earnings ratio is concentrated near the future earnings announcementand it is consistent with mispricing.? Risk associations have a positive association with the future returns.Thus, the research indicates a new evidence that mispricing and risk explanations may not be thebasis of finding the future returns as it does not explain the varying value to price ratio whenresidual income of the firm was taken into account.REFERENCES:Paper 1: copied Qiang Cheng. (2005). What Determines Residual Income? The AccountingReview, 80(1), 85-112. Retrieved from http://ezproxy.svkm.ac.in:2067/stable/4093162Paper 2: Myers, J. (1999). Implementing Residual Income Valuation with Linear InformationDynamics. The Accounting Review, 74(1), 1-28. Retrieved fromhttp://ezproxy.svkm.ac.in:2067/stable/248603Paper 3: copied Christensen, P., Feltham, G., & Martin G. H. Wu. (2002). “Cost of Capital” inResidual Income for Performance Evaluation. The Accounting Review, 77(1), 1-23. Retrieved fromhttp://ezproxy.svkm.ac.in:2067/stable/3068854Paper 4: copied Baginski, S., & Wahlen, J. (2003). Residual Income Risk, Intrinsic Values, andShare Prices. The Accounting Review, 78(1), 327-351. Retrieved fromhttp://ezproxy.svkm.ac.in:2067/stable/3203306Paper 5: copied Ali, A., Hwang, L., & Trombley, M. (2003). Residual-Income-Based ValuationPredicts Future Stock Returns: Evidence on Mispricing vs. Risk Explanations. The AccountingReview, 78(2), 377-396. 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